Nonperforming loans (NPLs) represent an ongoing challenge for major Chinese banks, given a mediocre outlook on the country’s economy. In response to the increase in NPL levels, Chinese banks have been taking action to avoid lending to risky borrowers. These include raising lending norms and taking a closer look at potentially problematic loans.

IEMS’ Kellee Tsai, professor and head of the division of social science at the Hong Kong University of Science & Technology, told SNL Financial that she expects the NPLs of Chinese banks to continue increasing. As quoted in the article, Kellee Tsai had the following comments:

“I expect NPLs will continue to be revealed. One thing that was keeping [NPL figures] from coming out was that loans could be rolled over or re-extended and repackaged in various ways,” Tsai said.

Tsai cited the weak outlook on Chinese property prices as one of the reasons why NPLs of Chinese banks will continue to rise. “Now that asset prices, especially [for] real estate, are softening and even declining in some areas, it makes it even harder to sustain the expected returns,” she said.

The reporting of NPLs in China has been criticized as having a low level of transparency, as the NPL ratios of most of the major banks have remained at around 1%.

The China Banking Regulatory Commission issued draft regulations in August that aim to tighten banks’ oversight of their off-balance-sheet activities. The draft rules, which were published by the regulator, require banks to oversee risks arising from financing activities via insurers, trust companies and securities firms using wealth management products or entrusted loans. Banks will also need to categorize their off-balance-sheet assets in terms of level of risk and capital costs.

“If [the draft regulations] are actually implemented, it will help to make a difference. But right now, banks are reluctant to expose themselves to bad loans because they are being scrutinized closely. So it is not just the regulations that are curbing bank lending, but also the political climate of cracking down on all sorts of off-balance sheet and less legitimate activities,” Tsai said.

The draft rules followed the introduction of new rules in May that aim to stop banks from disguising corporate loans as interbank transactions, which enabled Chinese banks to hold less capital and smaller reserves, and in turn, helped their balance sheets appear healthy.

Tsai said that while the draft rules are “badly needed,” they may be difficult to enforce. “The problem is that it is not easy to get banks to be completely transparent about the true destination of their loans. I don’t think I can go into more detail than that. Bank staff and staff managers can be pretty creative about it,” she added.

If [the draft regulations] are actually implemented, it will help to make a difference. But right now, banks are reluctant to expose themselves to bad loans because they are being scrutinized closely. So it is not just the regulations that are curbing bank lending, but also the political climate of cracking down on all sorts of off-balance sheet and less legitimate activities